Wednesday, March 26, 2014

Article on Forbes: China, Myth or Reality

China: myth or reality?

CHINA

Photo: Reuters.

The spectacular growth of China's economy is a reality, but it is a myth that may single-handedly save the world economy.

China, a country with a population of 1.3 billion population, 8.22 trillion economy that recently has been lowering its growth from 11% to almost 7% . Credited as being the current engine of growth for the world economy, the superpower of the future. So much so that many parents in different parts of the world want their children to learn the language that will help them to understand this culture that will dominate economically for decades.

Some interesting facts only for ease of reference: India has more than 1,200 million people and its current population is growing at a rate of 1.3% per year versus a 0.5% a year in China. Even so, the economy of India is only about 20% of the Chinese in size. As counterpart, United States has only 300 million population, but an economy of 15 billion dollars and the EU has 500 million population and a 16 trillion economy.

In short, China has 19% of the world's population, but 12% of global GDP, while the US has 5% of the world's population, but a GDP of 19% of the world and the EU 9% of the world's population, but a GDP approximately 20% of the global economy. Yet the weight of the EU, US and Japan represent a majority and significant percentage of the world economy. And in all three cases it's economies are struggling with a level of astronomical debt, rates of dismal economic growth and with deep problems of structural level. And it is unlikely these economies in the short and medium term will achieve a reasonable takeoff, given massive internal and external debt servicing that prevent a sustainable recovery.

Another aspect to consider with respect to China as an engine of growth is that the great economic expansion of the last two decades had not so much to do with the size of its population, but with the economic opening and the adoption of the model of global trade and a "controlled" version of new capitalism. China became the world's industry, with a cheap labour and flexibility for mass production. It became the country of exports by excellence, and thereby increased the purchasing power of a large part of the population and an enrichment of the coffers of the State, which finally resulted in a significant investment in infrastructure and consumer goods imports.

The commercial and fiscal surplus generated a number of astronomical reserves which were exponentially increased via a currency not tradable on international markets and a very competitive fixed exchange rate. While developed economies were devoted to borrow and consume, China dedicated to save and produce.

However, the lethargy of the world economy from the shock of 2007-2008 has been slowly diminishing the rate of growth of Chinese exports, which is has been translated also in a reduction of its growth rate. The decay of the net flow has been compensated in the past decade with an explosive growth in domestic credit by Chinese banks and financial system (see graph).

Source: World Bank (domestic currency).

In other words, the miracle of China's growth over the past decade, in particular, has been also by an explosion in consumption and spending on real estate and infrastructure, financed in an important part by domestic money creation. This in part also to meet the appetite of consumption and capitalism of the new Chinese citizen.

But as we've discussed in previous columns: the experience that is today evident in the developed world, is that growth via credit is a formula that can only turn badly when it is used excessively. And the performance of the additional credit begins to become marginal, as it is the proven case of the formula of printing of Japan and US. Of course unlike these, China has a significant amount of reserves, but those are in foreign currency and not necessarily on liquid investments. For this reason, it is presumable to think that Chinese finance could resort to the rescue of their financial system, but with that (as well as EU and Japan) it would only somehow cover the hole in the floor, therefore failing to kick start the economy again. Sooner or later the credit excesses will end up being paid somehow.

With anemic growth on the world economy and the impossibility of continuing to expand the domestic credit at previous rates, it is likely that China is destined to grow at an increasingly slower pace, with the consequent impact on the world economy which still relies on a fragile structure.